Pros and Cons of Active and Passive Investing

The active/passive investment debate has raged between investors for years – but the argument is fast becoming irrelevant as the underlying landscape of investment changes with new regulations.

The pros and cons of active or passive investment are simple –

  • Active investors urge putting a portfolio in the hands of a fund manager who keeps an eye  on the investments and works to outperform the market – for a weighty fee.
  • Passive investors take a hands-off approach and accept a lower return – but pay less in fees and charges

The problem comes when the expensive active manager fails to deliver the expected returns, or even worse, ends the trading year in a loss which is inflated by the fund management fees.

Passive investors can also experience disappointment in their returns and may rue lost potential profits for the sake of paying a fee.

Clear fee structures

Until now, investors have had no middle ground, but new regulatory policies arising from the ashes of the global financial crisis have opened the way for a hybrid investment solution.

Regulators accept investors come in different types, and some need more protection from the vagaries of the markets than others.

In Britain, the Financial Services Authority (FSA) is demanding fund managers give clear and transparent statements laying out just how much active management of investments or a pension cost each year.

Many investors may find the figures shocking in the context of low yields and interest rates.

The likely result, predict many City experts, is rising sales of low-cost, low-risk and low-return investment products.

ETFs to storm markets

Exchange Traded Funds (ETFs) are likely to take the markets by storm. The fees are cheap compared with fund manager charges – often just 0.2% of the fund value each year.

ETFs often track markets or commodities, depending on the wrapper, so they are listed in the same way as shares. This gives a variable price linked to investment return.

Investors still have to make sensible and informed buying and selling decisions, but the impact of expensive fund manager and administration charges is reduced.

Another attraction is ETFs do not come with exit fees – but your financial adviser or stockbroker may charge a fee that can vary significantly between firms.

Watch out for blending – the practice of charging extra costs for having active and passive investments in the same portfolio. In most cases, the need for the fee is not reasonable, so ensure your adviser explains in full why this fee is on the bill.

Leave a Comment